bond research . A new element in bond research that FIASI will be called on to address is the effects , both positive and negative , that AI will be introducing into the bond research world going forward .
Richard Nixon Presidential Library and Museum
President Richard Nixon , photographed at an outdoor press conference in 1971 . That year , President Nixon terminated convertibility of the US dollar to gold , effectively bringing the Bretton Woods system to an end . This was one of the events of the turbulent 1970s that led to the birth of the fixed income analyst .
event risk arose from leveraged buyouts ( LBOs ). These transactions , formerly limited to private companies , grew in scale and began to occur at public companies in the 1980s . Instead of dropping by one notch — from , say , Aa2 / AA to Aa3 / AA – — ratings often fell by two or more entire letter grades at a time ( A to BB , for example ) as debt replaced a large portion of the equity on the balance sheet .
Concurrently , the market for publicly rated speculative grade ( high yield ) bonds expanded greatly . For these issuers , default was a much less remote possibility than for investment grade ( Baa3 / BBBor higher ) companies . That made skilled credit analysts more valuable than ever to institutional investors and the Wall Street firms that served them .
In this altered environment , top credit ratings were widely disdained as a sign that the company was underleveraged , to the detriment of shareholders ’ return on equity . Therefore , even companies that remained within the investment grade category migrated , with management approval , toward lower ratings , thereby requiring more intensive monitoring by credit analysts .
The late 1980s brought innovations in securitization , such as collateralized bond obligations ( CBOs ) and collateralized loan obligations ( CLOs ). These , like the mortgage-backed securities that preceded them , necessitated new analytical methods . A vast trading market for leveraged loans emerged . Credit default swaps ( CDS ) were introduced in the early 1990s and became a prominent part of the financial landscape in the following decade .
Economic turbulence continued to create hazards and opportunities in subsequent years . Mortgage-backed securities were central to the financial crisis that triggered the Great Recession of 2008 – 09 . Detailed analysis of the mortgage pools in these instruments enabled some investors to reap huge gains through short-selling before the market blew up . On the corporate bond side , the Great Recession culminated in 2009 with the largest number of defaults since the Great Depression year of 1933 .
As recently as 2023 , optimization refunding analysis was again cited as an analytical tool in conjunction with the technique of advanced refunding of municipal debt with the utilization of taxable debt .
What the Future Holds
Beginning in 2021 , inflation once again reached historic highs and the Federal Reserve , beginning in 2022 , within a compressed period of time raised interest rates at an historic rate . As expected , the yield curve turned sharply inverse and bank failures followed , creating increased interest once again for credit and quantitative
Alfred Mazzorana began his fixed income analyst career on Wall Street in 1973 . He is a founding member of FIASI and served as its first treasurer and later president . Now retired , he is an active philanthropist and lives with his wife in Delaware and Vermont .
Special thanks to FIASI member and MoAF trustee Martin Fridson for his assistance with this article .
Notes
1 . The utility industry ’ s utilization of the GAAP revenue item known as “ Construction Work in Progress ” allowed the recording of a current expense ( i . e ., nuclear plant expenditures ) as revenue ; these revenues were not expected to be recovered from rate payers for many years into the future . Credit analysts removed this “ phantom ” implied revenue from their bond interest coverage ratios , adding to downward credit rating pressure .
2 . Long Island Lighting Co . had both a first mortgage indenture and a general and refunding mortgage ( second mortgage ), both of which incorporated a long list of “ supplemental ” covenants related to each bond issued .
Sources
Boyce , W . M . and A . J . Kalotay . “ Optimum Bond Calling and Refunding .” Institute of Management Sciences . 1979 .
Braun , Martin . “ States Wasted Billions by Refunding Debt Early .” Bloomberg News . July 14 , 2023 .
Fridson , Martin . “ The Transformation of Credit Research .” Bondweek . October 29 , 1984 .
Homer , Sidney and Martin Leibowitz . Inside the Yield Book : New Tools for Bond Market Strategy . Prentice-Hall , Inc .: New York . 1972 .
Murray , Roger F . “ The Penn Central Debacle : Lessons for Financial Analysis .” Journal of Finance . May 1971 .
“ Technical Features of High Coupon Bonds .” Paine , Webber , Jackson & Curtis , Inc . 1977 .
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